USD: the Fed turns, and the dollar with it
The US dollar advanced against every major currency over the week, with the dollar index finishing just over 1% higher and at its strongest level in around six weeks, after the Federal Open Market Committee raised the target range for the federal funds rate by 25 basis points to 3.75% to 4.00% on Wednesday, the first increase in three years and a unanimous one at that. The vote matters as much as the decision.
Chair Kevin Warsh used the press conference to reaffirm the Committee's commitment to bringing inflation back down and signalled at least one further increase before the end of the year, which markets interpreted as a deliberate effort to remove any ambiguity about the direction of travel. That guidance is what drove the dollar rather than the hike itself, which had been well telegraphed and largely in the price by Monday. Currencies respond to the path, not the payment, and the path Warsh described was steeper than the one that had been assumed.
The mechanism by which the dollar gained is worth spelling out, because it is not simply a matter of higher US rates attracting capital. When the world's reserve currency enters a tightening cycle driven by an energy shock, every other central bank is forced to choose between matching it and accepting a weaker currency that imports the shock at a worse exchange rate. Some this week chose to match, some did not, and the dollar gained against both groups because the yield advantage it started with was already substantial.
Taken together, the week established the Federal Reserve as the hawkish anchor of the developed world rather than one participant among several. The Bank of England held, the Bank of Canada is still on hold, and the Swiss National Bank remains at zero. Against that field a central bank that hikes unanimously and promises more is a meaningful differentiator. The question now is how much of that differentiation is already reflected.
Attention now turns to the personal consumption expenditures deflator at the end of the week, the Committee's preferred inflation measure and the first read the market will get on whether the energy pass-through the Federal Reserve is worried about is showing up in the core series or remaining confined to the headline. That distinction will shape how much of the remaining tightening the market is willing to price.
Before that, Wednesday's flash purchasing managers' indices will offer an early look at whether the hike and the oil price are yet showing up in activity, and a run of Federal Reserve speakers through the week, beginning with Goolsbee on Monday, will be closely watched for any softening of the tone Warsh set. President Xi's visit to the United States sits over the week as a separate source of headline risk, with tariffs and trade the obvious points of friction.
Overall the dollar enters the week with momentum and a policy story that is easier to articulate than almost any of its counterparts. The risk to that position is not a rival central bank but the American data itself, because a tightening cycle justified by an oil price is only as durable as the oil price.
EUR: a hike already spent
The euro lost close to 1% against the US dollar over the week and finished below $1.15 at its weakest level since late July, having fallen on each of the sessions following the European Central Bank's move and again after the Federal Reserve's decision on Wednesday. A currency that weakens in the week after its own central bank tightens is telling you something about relative position rather than absolute policy.
The Governing Council lifted the deposit rate to 2.50% the previous Thursday in a unanimous decision, its second increase of the year, and raised its inflation forecasts alongside it. The problem for the single currency is arithmetic: the Federal Reserve took its ceiling to 4.00% on Wednesday, and a gap of roughly a percentage point and a half is not closed by a quarter point delivered a week earlier. Markets have also begun to question how much further Frankfurt will go, with money market pricing now implying only around an even chance of one more increase before December.
In the euro area the energy shock is a more complicated problem than it is in the United States, and this is the part that deserves unpacking for anyone watching from outside. A region that imports most of its energy faces a rise in the oil price as both a cost shock to business and a tax on household consumption, which lifts measured inflation while simultaneously weakening the demand that would normally justify responding to it. The Council is therefore tightening into a slowdown it is partly importing, which is precisely the position that makes a central bank hesitate at the second or third step.
For now the euro is caught between two competing forces: an inflation picture that argues for more tightening and a growth picture that argues against it, with the currency market siding with the second. Until that tension resolves, the single currency is likely to take its direction from the dollar side of the pair rather than its own.
Attention now turns to Wednesday's flash purchasing managers' indices for Germany and the euro area as a whole, which are the cleanest early read available on whether the energy shock has begun to bite into activity in the way the currency market appears to be assuming. The composite reading, and particularly the split between manufacturing and services, will do more to shape the December pricing than any single inflation print.
A resilient set of numbers would give the hawks on the Council a straightforward argument for a further move and would put a floor under a currency that is presently trading on a deteriorating growth narrative. Conversely, a soft composite would confirm the market's suspicion that Frankfurt is close to the end of its cycle and would leave the euro exposed to a dollar that has just been given explicit forward guidance in the opposite direction.
The US personal consumption expenditures deflator at the end of the week remains the larger event for the pair in absolute terms, as does President Xi's visit to Washington for the broader risk backdrop.
GBP: the Bank that did not move
Sterling lost ground against both the US dollar and the euro over the week after the Bank of England left Bank Rate unchanged on Thursday by a six to three vote, a decision that had been widely expected but which landed awkwardly in a week when the Federal Reserve had raised rates and the European Central Bank had only just done so. Being the one that held is a position, and the currency market priced it as one.
Markets interpreted the vote split and the accompanying statement as leaning more dovish than had been hoped, which is the more meaningful point given how much tightening remains priced into the UK curve before the end of the year. The Committee held despite inflation rising, despite oil remaining above $100 a barrel, and despite a rise in retail sales, and that combination invites the conclusion that the bar to moving is higher at Threadneedle Street than elsewhere.
The Bank also signalled it would slow the pace of its quantitative tightening programme, which triggered a sharp fall in gilt yields and, in the odd way these things work, relieved some of the pressure on the currency at the same time as the rate decision was adding to it. A slower pace of balance sheet runoff reduces the supply of gilts the market has to absorb, and a bond market under less strain is a friendlier environment for sterling than a disorderly one, even if the rate differential is moving the wrong way.
The United Kingdom is the developed economy where the oil price does the most damage to the policy debate, because it arrives as an inflation problem in a country whose inflation problem was never fully resolved from the last cycle. The Committee is being asked to distinguish between a price level shock it should look through and a persistence problem it should not, and three of its members concluded this week that it should not wait to find out.
For now sterling is under pressure on the rate story and finding modest relief in the gilt market, which is an uncomfortable combination to trade. The currency's direction over the coming weeks likely rests on whether the three dissenters become a majority.
Attention now turns to Wednesday's flash purchasing managers' indices, which carry more weight than usual because the Committee has effectively told the market it wants more evidence before it moves. The services reading in particular, given its relationship with domestic price pressure, will be closely scrutinised.
Beyond that the calendar is thin by recent standards, which leaves sterling largely at the mercy of the dollar and of the US personal consumption expenditures deflator at the end of the week. Any commentary from Committee members will be read for signs that the dovish majority is narrowing, particularly from those who voted to hold.
JPY: a hike that did not help
The yen weakened to two-week lows against the US dollar over the week, and did so in the immediate aftermath of a Bank of Japan decision to raise its policy rate by 25 basis points to 1.25%, the highest level since 1995, with two officials dissenting. A currency that falls on its own central bank's tightening is the clearest illustration available of how completely the Federal Reserve dominated the week.
The mechanics are straightforward once stated. The move had been widely anticipated and was therefore largely in the price before it happened, while the Federal Reserve's own increase and its guidance toward further tightening arrived as genuine repricing, so the differential between the two currencies widened in the dollar's favour on the week despite Tokyo having moved in the same direction. The two dissents compounded the problem by suggesting the Board is not unanimous about how much further it wants to go.
That interest rate differential remains enormous in absolute terms even after this week, and that is the point that gets lost when the story is told as a series of hikes. A policy rate moving from 1.00% to 1.25% against a US range moving to 3.75% to 4.00% is a narrowing measured in basis points against a gap measured in percentage points, and carry flows respond to the level rather than the direction. Japanese authorities intervened earlier in the month when the yen came under pressure, and the memory of that is now the more relevant consideration for anyone positioned short.
For now the yen is trapped between a central bank that is tightening too slowly to close the gap and a Ministry of Finance that has shown it will act when the move becomes disorderly. That combination produces a currency that drifts weaker and then corrects sharply, which is what September has looked like.
Attention now turns to the broader dollar story rather than anything domestic, because with the Bank of Japan meeting behind it the yen becomes primarily a function of US yields for the next several weeks. The personal consumption expenditures deflator at the end of the week is therefore the release that matters most.
Any official commentary on the exchange rate will be closely watched, given the intervention earlier in the month and the speed with which the currency has given back the ground it recovered then. The level at which officials become uncomfortable is not published, but the market's working assumption is that it is not far above where the yen sits now.
CAD: an oil currency that stopped behaving like one
The Canadian dollar was the weakest of the major currencies over the week, losing ground not only against a strengthening US dollar but also against the euro, the yen and the Swiss franc, and holding its own only against the Australian dollar. For a currency whose principal export sells above $100 a barrel, that is a result which requires explanation rather than a headline.
The explanation is the Bank of Canada, which has now held its policy rate at 2.25% for seven consecutive meetings, and which therefore found itself standing still on Wednesday as the Federal Reserve moved the US range to 3.75% to 4.00%. The yield gap between the two North American economies is the widest it has been in this cycle, and in a week when rate differentials were the market's organising principle, that gap was always going to dominate the commodity story.
Governor Tiff Macklem has shifted his tone considerably, warning at the September decision that inflation risks are rising and that policymakers are prepared to raise borrowing costs multiple times if inflation stays too high, with higher energy costs rather than tariffs now identified as the principal danger. Headline inflation has been running around 3% on persistently higher petrol prices. The market has heard the warning and has not yet believed it, which is the essential problem for the currency: a central bank that talks hawkish and acts patient gets neither the credibility nor the carry.
There is a second reason the oil channel failed to support the currency this week, and it is worth making explicit. When an oil price rise is driven by war risk rather than by demand, it arrives alongside risk aversion, and risk aversion is a bid for the US dollar. The terms-of-trade benefit to Canada and the safe-haven flow into the greenback therefore pull the same pair in opposite directions, and this week the flow won.
Attention now turns to Governor Macklem, who speaks early in the week and whose language will be examined closely for any sign that the warning issued at the September decision is hardening into an intention. With the Bank on hold and the Federal Reserve tightening, the Canadian dollar needs the rhetoric to become policy.
Beyond that the week offers the North American currency little of its own, leaving it exposed to the flash purchasing managers' indices on Wednesday and the US personal consumption expenditures deflator at the end of the week. The oil price and the course of the Middle East conflict remain the wild card, though this week demonstrated that the relationship between crude and the loonie is not currently working in the textbook direction.
CHF: zero rates in a tightening world
The Swiss franc spent most of the week under pressure, approaching its lows for the year in the sessions leading into the Federal Reserve decision, before regaining a portion of the lost ground on Friday as US yields eased back from their post-meeting highs. The shape of the week matters more than the net move, because it shows exactly what the franc is now trading on.
The Swiss National Bank has its policy rate at zero and is widely expected to keep it there, which in a world where the Federal Reserve has moved to a 3.75% to 4.00% range and the European Central Bank sits at 2.50% leaves the franc with the least attractive carry in the developed world by a considerable distance. Policy divergence of that magnitude is a structural headwind, and it is the reason the currency has struggled even in a month when a Middle East war has been the dominant global story.
That last point is the genuinely interesting one. The franc is the archetypal safe-haven currency, and September has provided precisely the sort of geopolitical escalation that ordinarily produces safe-haven demand, yet the currency has spent the month closer to its lows than its highs. The explanation is that safe-haven flows and carry flows are competing for the same currency, and with the rate gap as wide as it now is, the carry side is winning. A haven that costs three percentage points a year to hold is a haven fewer people want.
The Swiss National Bank's tolerance for all of this is not unlimited, but its incentives run the other way from most of its peers. Swiss inflation remains within the zero to 2% band, and a weaker franc is the mechanism by which an economy with no inflation problem imports a little of one from a world that has too much.
Attention now turns to Thursday, when the Swiss National Bank announces alongside the Norges Bank, the Riksbank and Banxico, in what has become the most concentrated single day of central bank activity outside the major meetings. Expectations are firmly for no change at zero.
The franc's reaction will therefore depend entirely on the accompanying language, and specifically on whether the Bank acknowledges any discomfort with the currency's weakness or with imported price pressure from energy. Conversely, a statement that simply restates the inflation band and moves on would confirm the market's assumption that Switzerland intends to sit out this tightening cycle entirely, and would leave the franc trading on the dollar's momentum for the remainder of the month.
Wednesday's flash purchasing managers' indices and Friday's US inflation data frame the week on either side of the decision.
NZD: a good number that went nowhere
The New Zealand dollar recovered from a ten-week low over the week with the help of a second-quarter growth report that beat expectations, though the recovery was modest and the currency finished lower against a US dollar that was stronger against everything. The economy expanded 0.2% in the June quarter against a flat forecast from the Reserve Bank and a median estimate of 0.1%, with annual growth at 2.6% comfortably above the 2.2% expected.
The market's reaction to that beat was close to nothing on the day, which is the detail that tells the story of the week. When the world's largest central bank is repricing its entire policy path, a quarter-point surprise in a small open economy's growth rate is simply not large enough to register, and the kiwi found itself moving on the dollar leg of the pair rather than its own.
Where the data did matter was in the rate pricing. The Reserve Bank of New Zealand took the official cash rate to 2.75% at the start of the month with inflation running at 4.1% and described the economy as recovering, and markets now carry roughly a 60% probability of a further move to 3.00% in October. A growth print that exceeds the Bank's own forecast makes that easier to justify, and it is through that channel rather than through any immediate flow that the GDP number will support the currency.
The comparison with Australia is instructive and cuts both ways. New Zealand has the higher inflation rate and the lower policy rate, which argues for more tightening ahead, but it also has the smaller and more exposed economy at a moment when the global backdrop is deteriorating. The kiwi is therefore the higher-beta expression of the same antipodean rate story that has been supporting the Australian dollar, with everything that implies in both directions.
Attention now turns to the offshore calendar, which is where the kiwi's direction will be settled over the coming week given the absence of significant domestic releases. Wednesday's global flash purchasing managers' indices and the US personal consumption expenditures deflator at the end of the week are the two events capable of moving the pair.
The October meeting remains the domestic focus, and with pricing only around 60% committed there is more room for the market to move on incoming data than there is across the Tasman, where the September decision is close to fully priced. Any commentary from Reserve Bank officials will be read in that light.
For now the New Zealand dollar sits in an awkward position: supported by a credible tightening story and undermined by a global risk backdrop that punishes exactly this sort of currency. Which of those dominates over the next fortnight is more likely to be decided in Washington than in Wellington.